EU Learns to Beware of Bearing Gifts to Greeks

Having nudged Portugal into a bailout, the EU expected a respite, but the worsening of the Greek crisis has awakened nightmare scenarios.

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Amiel Ungar, 08/05/11 20:10 | updated: 00:32

Drachma coins

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The European financial debt crisis is a problem that refuses to go away. Having breathed a sigh of relief by convincing Portugal to go for bailout last week and hoping to avoid further contagion, Europe now confronts a worse financial nightmare.

The bailouts were sold to the public as a bitter medicine for both the lending and recipient countries, but one that if taken according to the prescription, would bring about solvency and closure. This assumption is unraveling in Greece, the first bailout recipient.

The financial markets simply refuse to believe that Greece can avoid default on its debts --the purpose of the entire exercise. As a result, interest on Greek debt is skyrocketing and those who hold Greek bonds see them trading at a steep discount.

An article in Barron's provides the numbers that explain the skepticism. Last year the Greek government deficit was 10.5% of GDP and with austerity in a contracting economy, Greece will not make a 3% cut in its deficit. The promised higher tax collections and money realized from privatization appears impossible.

Greece already pays 10% of GDP in interest costs alone and with GDP scheduled to contract, the numbers simply do not add up. Demonstrations and strikes against the Greek Socialist government increase the pessimism. The only way to make them add up will be more bailout aid.

Each time the more financially stable and affluent Eurozone countries are asked to extend a bailout, they must impose either a tax or credit burden on their citizens, so that is becoming an increasingly tougher sell. This is within the Eurozone.

Imagine the vicissitudes of selling the package to countries outside the Eurozone, like the British who contributed to the Irish and Portuguese rescues. David Cameron is already receiving blunt warnings from his Conservative Party to keep Britain out of any bailout.

The Greek financial Crisis prompted a meeting in Luxembourg of finance ministers from Luxembourg, France, Germany and Spain. As it was secret, rumors were rife, including the idea that Greece would exit the Euro and revert to the Drachma allowing her to export her way out of debt with a devalued currency. This elicited heated denials.

Luxembourg Prime Minister Jean-Claude Juncker said: ‘We have not been discussing the exit of Greece from the euro area, this is a stupid idea, it is an avenue we would never take.’ Greek Prime Minister George Papandreou denounced what he called are groundless reports, provocations put out by irresponsible people aimed at speculation, at profiteering."The scenario of a country exiting the euro bloc has never been previously considered and the complications appear daunting.

If there is no further bailout and no exit from the euro bloc, this leaves debt restructuring in which creditors will either receive less of their loan back or wait longer to receive it. This option has been resisted within the European Union, because it could threaten the stability of the European banks.

An unpalatable choice between problematic alternatives may soon be on the horizon.